Tax reductions might be more effective than RRR cut to support the real economy


The growth momentum in China has shown signs of weakness as seen by recent economic data. For example, the September NBS manufacturing PMI declined to 50.8 from 51.3 in August, with major sub-indexes edging down1.

On Oct. 7, the PBoC announced the fourth reserve requirement ratio (RRR) cut this year, cutting by 100bps which reduces the RRR for large banks to 14.5%2. The amount of liquidity released from this cut will likely amount to Rmb 1.2trn2. Rmb 450bn will be used to replace the Medium-term Lending Facility that is maturing in October, while the rest will be used to support liquidity, and we believe this will alleviate funding pressure from tax submission in October2. We think the effect of RRR cut is limited, as evident by the slumping SHIBOR rates, indicating the unwillingness of banks to make new loans to the real economy despite sufficient liquidity.  Nonetheless, the RRR cut may help local governments sell more bonds to banks. Bond issuances are expected to peak between 3Q and 4Q which may boost total social financing and infrastructure investment in 4Q18 and next year. In addition, we believe more fiscal and monetary policies will be released in the coming months as the Minister of Finance announced that he is studying tax cuts possibilities.  Finally, while the RRR cut will add to RMB depreciation pressure, we believe the central government has placed higher priority on tackling internal challenges over external uncertainties at this juncture, and therefore should be determined to avoid high fluctuation of RMB exchange via stringent capital control for the rest of 2018.

Although we’ve shifted to a more conservative strategy in volatile markets, we stay very alert to the possibility that the tide could turn when the government initiates more aggressive measures to support the economy. The Fourth Party Plenum of the 19th Party Congress is scheduled to take place around the latter half of November. We expect the government to form internal consensus on how strong the stimulus measures should be implemented.  For instance, VAT rate cut could be an effective tool to boost consumption and GDP.  We estimate that for every 1% cut in VAT, there would be RMB520bn (0.6% GDP boost) worth of tax savings to the general public3. Additionally, for every 1% rate cut of social security contribution by corporates and/or individuals would reduce their burdens by Rmb250-300bn3. We consider various tax reductions to be much more direct and powerful tools to support the real economy than RRR cuts, and we believe that the government will implement those measures when necessary.

[1] Source: National Bureau of Statistics, as of September 2018

[2]Source: BNP Paribas, as of October 2018

[3]Source: Zeal Asset Management Limited, as of October 2018

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. You may lose part or all of your investment. You should not make an investment decision solely based on this information. If you have any queries, please contact your financial advisor and seek professional advice. This document is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

Tracking Investment Sentiment via Two Main Goal Posts


The Chinese market experienced considerable volatility in July and August. The market first took a leg down as the Chinese economy showed signs of weakness when the government continued its deleveraging efforts. The market was expecting some sort of support by the government but was worried whether it would come too late or at all. Then on July 23rd, at the State Council’s executive meeting chaired by Premier Li Keqiang, the government gave a clear indication that it is looking to better utilize its fiscal and monetary policies to support domestic demand, boost the development of the real economy, and make sure the economy performs within a reasonable range amid external uncertainties. Afterwards, roughly 1 week later on July 31st, President Xi Jinping chaired the Politburo meeting which stressed on more proactive fiscal policies, steady monetary policy versus the previous tone of “steady and neutral monetary policy”, supply-side reforms, and accelerating infrastructure fixed-asset investment. The government indicated that they would support the economy when needed and take concrete actions. But the markets did not experience a prolonged recovery and instead took another leg down when poor economic figures were released in August.

So far this year, the measures implemented include three Reserve Requirement Ratio (RRR) cuts, expansion of the collateral accepted for Medium-term Lending Facility (MLF), and increase in foreign exchange risk reserve ratio of forward sales from 0% to 20%1 . Furthermore, the release of implementation details of the new asset management rules in July was a marginal relaxation from the government’s guidance in April which gave a relief to the market. The market recovered towards the end of the month on the back of these slightly more encouraging developments. However, risk appetite currently is still quite weak on the back of the escalating trade tension with the US. Furthermore, the sudden deterioration of the eruption of a typical emerging market crisis in Turkey has significantly raised investors’ risk alertness. The market is also concerned about whether the government’s stimulus will be effectively implemented, or whether it would need a significant time period before it proves to be effective.

We are tracking two main goal posts to gauge whether the government is successful in its implementation; the first is Total Social Financing (TSF) which has been decelerating for almost a year. We would like to see TSF growth to stabilize or to pick up. Past observation tells us that TSF generally leads economic figures by around 6-9 months [See Chart 1], and the stock market bottoms earlier than the economy.  Secondly, we are tracking China’s credit spread which is at credit crunch levels, and we would like to see it comes down meaningfully [See Chart 2]. We believe investment sentiment will significantly recover if positive signs emerge from these two indicators.

July TSF dropped to 1.04 trillion yuan, declining by 10.7% YoY1. But we’re encouraged to see sequential growth of adjusted TSF rebounded to 13.3% MoM annualized from 7.6% in June2. Furthermore, there are signs that the effects of government actions are starting to surface as the cost of money in China is eye-catchingly low recently. The 1 Month SHIBOR has recently moved down significantly to levels unseen since 20163. For smaller banks needing to sell negotiable certificates of deposit (NCDs), yields are near record-lows. Currency forwards, interbank borrowing costs, government bonds and interest-rate swaps show a similar picture. We believe the trend is likely to persist as China embarks on a 2009 US-like monetary easing together with credit tightening to deleverage the economy in an orderly fashion.

[1] Source: People’s Bank of China as of Aug 2018

[2] Source: CICC Research as of Aug 2018

[3] Source: Bloomberg as of Aug 2018

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. You may lose part or all of your investment. You should not make an investment decision solely based on this information. If you have any queries, please contact your financial advisor and seek professional advice. This document is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.